by Judy Baker, Argo Gold
In the first article on “Why did gold bullion make a twenty percent gain in 2016?”, the theme of Negative Real Rates being echoed from economists seemed to be the catalyst that shook investor confidence in paper currencies of the biggest economies of the world and resulted in material investment in gold bullion and gold stocks.
In this article I am going to discuss why we have negative real rates and how did we get here?
The easiest thing to do is look at the central banks for the US, Europe, Japan and England and blame them. These central banks have had low interest rate policies for a decade in an attempt to continue to stimulate their economies. A low interest rate policy also drives up the equity markets and other types of investments as investors look for a better return on their money. Low interest rates fuel housing prices as the carrying cost on the mortgage capital decreases. This scenario is not really a problem or a situation.
However, within this scenario various financial firms packaged up high risk mortgages and other type of debts and re-rated them as high quality, low risk mortgages and debts. In late July 2008, investors in some of these apparent high quality mortgage funds were told the funds were being wound up and they would be getting cents on their dollars. Things spiralled quickly down from here as the creditworthiness of everything was questioned, markets crashed, some of the high yield markets were frozen and overnight money markets were in jeopardy because the banks didn’t trust each other’s liquidity let alone the liquidity of major corporations.
The 2008 financial crisis resulted in the central banks and governments stepping in to ensure liquidity and minimize the shock waves through the economy. Hence, ongoing low and lower interest rates to try and continue to stimulate the economy. The central banks for the US, Europe, Japan and England were now stuck in this low interest rate world. From London Mark Carney announced that low interest rates were the “new norm”. At this juncture, there was definitely a situation but not necessarily a problem.
The Chinese economy and the Chinese government stimulus post 2008 for almost 5 years created a pocket of growth - that as the second biggest economy in the world - definitely helped world GDP. Apparently though, this was not enough and significant government open market operations were adopted by the US, Europe and Japan to stimulate their own economies. Whatever it is called - creating money out of thin air, spending electronic cash, running the printing presses, quantitative easing, QE or ECB bond buying – ultimately it must impact the value of currencies. A unit of paper currency can’t be worth as much after ongoing open market operations by governments as before. Now we have a situation and a problem.
Interest rates were already low for investors. Now the value of a dollar isn’t what it was. The outcome is Negative Real Rates.